Why Lenders Might Forgive Your Debt

From 2006 to early 2012, lenders foreclosed on 5 million homeowners.

From 2006 to early 2012, lenders foreclosed on 5 million homeowners.

In general, lenders are more likely to forgive your debt when it's their best option financially. Ideally, your lenders want to collect all of the principal and interest you owe them. Should it become apparent that is just not going to happen, however, some lenders might realize it would be better for them to modify your loan in a way that includes some forgiveness of debt.

Basics

Debt forgiveness is rare. You can't simply call up your mortgage lender, claim you're having financial difficulty and expect that your debt will be forgiven. Despite the increased usage of mortgage modifications to improve the housing market, only 8.5 percent of all loan modifications include some amount of debt forgiveness, says a March 2012 Bloomberg.com article. And most of these are from private lenders, not government loan programs. It's far more common for struggling homeowners to be presented with late charges and legal fees, not debt forgiveness, when they can't make mortgage payments.

Avoid Foreclosure

A primary reason lenders forgive debt is to avoid the cost and hassle of going through the foreclosure or repossession process. On secured loans, like mortgages and car loans, lenders can reclaim your property if you miss several payments. However, the lender typically makes out better when you repay most of the debt according to your loan terms. For this reason, lenders sometimes modify your loan terms and reduce your total debt burden to give you more manageable monthly payments.

Success Rates

The most logical reason for lenders to forgive debt is that, as a July 2009 Bankrate.com article states, statistics show debt forgiveness is one of the most effective tools in loan modifications. Despite this, lenders more frequently look to rate reductions or rate freezes, term extensions, and adding the missed payments and late fees to the debt. Since borrowers are more likely to get back in line with a reduction in loan principal, however, some lenders do find the action sensible.

Deferrals

Principal deferrals are another common modification tool private lenders use instead of debt forgiveness. In fact, 30 percent of private investors and 39 percent of bank lenders offered principal deferrals as part of loan modifications in the first quarter of 2012, according to the U.S. Office of the Comptroller of the Currency. A principal deferral reduces monthly payments and stretches loan terms rather than reducing the debt owed.

 

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